Beyond the Bears

By Amy Domini, June 2001

The startling decline in U.S. stock markets is the result of long-term economic trends exacerbated by current events. The slowdown in technology spending, the unanticipated radicalism of the current administration, and reduced consumer confidence have propelled us into a bear market. However, a growing income and wealth gap and an increasingly large economic underclass are the root causes of the market's current dive.

While all eyes are focused on the severity of the market's slide, little attention is paid to the necessary preconditions for a healthy national economy, and the connection between a truly healthy economy and a strong stock market is all but ignored.

Why did the market downturn occur at this particular time? Several conditions are to blame. First, technology advances have slowed. During the past four years, the bull market to a large extent was sustained by ever-increasing tech spending. Technological advances - the Internet, in particular - forced corporations to cast aside their traditional framework for considering capital expenditures. CEOs who failed to spend rapidly and heavily on an interactive Website, for example, put their careers on the line. But once a business has built an information technology system, the phase of large capital outlays is complete; gains from continued build-out are minimal. Without the huge driver of technological advances that made previous innovations obsolete, the rate of new tech orders slowed. Had the sector been a smaller component of the market, it would not have had such a dramatic effect, but technology represented about 27 percent of the S&P 500 Index last fall. As went technology, so went the market.

Second, Washington has changed. Surprisingly little has been made of the fact that the market's decline coincided with the presidential election. Although George W. Bush is clearly friendly to business, he is also a change agent, and Wall Street does not like change. Furthermore, the changes he has implemented during his first few months in office conflict with the attitudes of most Americans, including business leaders. An April 2001 poll by CBS makes this clear. Only 38 percent of Americans favor a large tax cut; 61 percent think protecting the environment is more important than producing new energy; and 59 percent don't want to ease regulations on carbon dioxide emissions. Furthermore, no American utility has successfully ordered a nuclear power plant since 1973, and 89 percent of utility CEOs have said that their companies would never even consider ordering such a facility. Nonetheless, the cornerstone of the administration's energy policy is nuclear power.

After nearly 100 days of controversial cabinet nominations, unpopular rollbacks of consumer protections regarding safe food and drinking water, attacks on already weak laws that conserve our natural environment, removing labor's right to engage in fund-raising while leaving corporate political action committees in place, and eroding consumer protections in bankruptcy proceedings, a majority of Americans are shell-shocked, and Wall Street has the jitters.

A third cause of the market's current turmoil is the undermining of consumer confidence. Prolonged exposure to a bombardment of advertising has convinced the American public that more is better. Just as World War II trained an entire generation of citizens to save its waxed paper for reuse, a new generation of consumers has been trained to borrow as much as possible to buy as much as possible.

Meanwhile, the false sense that one could afford more has been buoyed by a steady new source of cheap goods, largely manufactured in sweatshop conditions. Although U.S. household spending on clothing decreased during the past few decades, the far more costly expense of housing skyrocketed. In 1972, the average American household spent 31 percent of its income on shelter; in 1997, the cost was 37 percent.

No wonder consumer debt doubled over the past decade, leading to the current dramatic slowdown in our spending. Even those not in debt are reluctant to make large purchases following the announced layoffs of 22,000 workers at Motorola, 9,600 at Procter & Gamble, 8,500 at Cisco Systems, 7,000 at Sara Lee, and 6,000 at Whirlpool, to name just a handful of companies in the midst of downsizing. In such an environment, consumer confidence crumbles.

Long term, a healthy stock market depends on a healthy economy, and the U.S. economy increasingly depends on consumers. According to estimates, consumer spending accounted for 63 percent of the gross domestic product in 1970; today, it makes up 68 percent of the GDP. Therefore, in order to gain a clear understanding of the nation's economic health, we must first examine the fiscal health of the consumer. Unfortunately, the news in this regard is not good. Wealth and income disparities are increasing. An expanding underclass has no stake in the nation's future. Historically low unemployment levels hide the vast number of workers living on low wages.

The growing weakness of the consumer's power matters all the more since the other two components of GDP - government and business - are unlikely to pick up the slack. Government spending, as a percentage of GDP, will continue to shrink until more people are willing to pay higher taxes. The contribution businesses make to GDP through investments in plant, labor and equipment will not increase until outsourcing to cheaper foreign markets wanes.

How serious is the U.S. consumer's condition? The growing gap between rich and poor has been well documented, though often overlooked. The U.S. Census Bureau measures income distribution with the Gini coefficient, which ranges from 0 to 1, with 0 representing absolute income equality across all households and 1 indicating that all the nation's income went to a single household. According to a U.S. Census Bureau report, "Generally [since 1969], the long-term trend has been toward increasing income inequality… Most noticeably, the share of income controlled by the top 5 percent of households has increased from 16.6 percent to 21.7 percent. Over the same time period, the Gini index rose 17.4 percent to its 1998 level of .456... The wage distribution has become considerably more unequal with workers at the top experiencing real wage gains and those at the bottom real wage losses."

The widening income gap is not objectionable solely on moral grounds. It is bad economic policy. The ripple effect of one wealthy individual buying a $50,000 Mercedes or landscaping a multi-acre property is not nearly as economically beneficial as 2,000 ordinary families purchasing lawn mowers, sofas, and storm windows. But from 1969 to 1999, the top 20 percent of U.S. households saw their share of national income grow from 43 percent to 49.4 percent. During the same period, the lowest 20 percent saw their share drop from 4.1 percent to 3.6 percent.

Wealth inequality has grown at an even more staggering rate. In 1998, the Gini coefficient measured the nation's wealth inequality at .796. The bottom 90 percent of the population holds the lowest percentage of the nation's wealth (31.3 percent) since the Federal Reserve began collecting this data in 1963.

Productivity gains in technology and the long-running bull market did not lead either to more disposable income or to greater wealth for the majority of Americans. Had that been the case, vigorous individual spending would have stimulated economic activity, allowing the nation to weather the shocks of a new administration, a slowdown in technological advances, and a drop in consumer confidence.

Worse than the broadening income and wealth gaps between the haves and the have-nots is the nation's swelling underclass, which has no economic or social stake in the country's health. Historically, capitalism has succeeded magnificently in the United States but has failed in many other countries. The reasons are clear. Throughout Africa, Latin America, and the Former Soviet Union, most citizens do not share in their nation's well-being. They have been continuously victimized by organized crime. Even in nations where hooligans are not in charge, rampant cronyism produces the same effect. The people are subordinate to their nation's elite because of their inability to own land, cruel bankruptcy laws that turn people into virtual slaves, and income disparity. Under such conditions, capitalism and its attendant benefits cannot thrive.

Why, then, have we in the United States spent 25 years pursuing public policies that lead us in the same direction? We have dismantled bankruptcy protection laws. Mandatory sentencing, warrantless searches and seizures ,and the erosion of the attorney-client privilege-all under the guise of supporting a woefully misguided and unpopular drug policy-have created an enormous infrastructure that perpetuates enduring poverty and organized crime. Meanwhile, corporate lobbying is as pervasive and effective as any form of cronyism encountered in lesser developed economies. The basic underpinnings necessary for capitalism to work have been seriously weakened.

The long-running bull market did not make more people believe they had a stake in the system. As of 1999, the median U.S. household income was $40,816. Half of the nation's households must budget their food, clothing, shelter, health care, and other costs out of less than this amount. They have had no real income growth since Richard Nixon was in office, when the nation's median household income stood at $35,839 (in 1999 dollars). It gets worse: 20 percent of U.S. households have a median income of $17,196.

For a mounting number of people, there is no American Dream. In 1999, the U.S. Department of Agriculture estimated that 10.5 million households, about 31 million people, did not have access to enough food to meet their basic needs. One out of every 137 Americans is behind bars. Last year, 1.2 million people declared bankruptcy; 98 percent of bankruptcy claims were filed by individuals, not businesses.

It seems extremely unlikely that these societal trends can be dealt with effectively over the short term. However, certain industries may do well for brief spurts. A Desert Storm II might well stimulate oil stocks and armament manufacturers. Continued assault on personal freedoms and protections might give a boost to for-profit prison companies. And another great leap forward in technology that creates another surge in demand may push some stock prices higher. Most likely, market rallies will be industry-specific for the foreseeable future.

Investors must recognize the logic of pursuing public policies that support healthy capitalism and rekindle economic growth. It's simple: A strong market depends on a healthy economy, which in turn depends on a healthy society. We must address wealth and income disparities and the growing underclass who feel abandoned and expendable. Otherwise, we defer the ability of financial markets to return to health.

Amy Domini, the founder of Domini Social Investments, is the author of Socially Responsible Investing: Making a Difference and Making Money (Dearborn).